A measure of how fast prices rise, an inflation rate is a key factor in the overall health of the economy. It affects consumers by reducing their purchasing power, businesses by increasing the cost of raw materials and wages and governments by raising or lowering interest rates on debt. A low, steady or predictable rate of inflation is generally viewed as positive for the economy.
To calculate a country’s inflation rate, government agencies often use a basket of goods that represent what people buy on average. The price of each item is compared to the same one from the previous year and the change is the inflation rate. The Consumer Price Index (CPI) is a popular measure of inflation but other measurements exist, such as the Producer Price Index (PPI) and the Gross Domestic Product price index. Policymakers also focus on core consumer inflation, which excludes volatile food and energy prices that are more susceptible to short-term supply and demand conditions.
Inflation happens when an increase in the money supply causes prices to rise and works its way up the production chain until it hits consumers. This is sometimes referred to as “demand-pull inflation.” A sudden and rapid recovery in consumer demand, such as the COVID-19 pandemic, caused demand-pull inflation that was felt by everyone from grocery stores to semiconductor manufacturers.
Inflation tends to hurt those with the lowest incomes first, including seniors and people living on fixed or low salaries. When prices rise, these groups have a harder time making ends meet, especially since they typically spend more of their income on essentials like food and utilities.